NEW YORK (Dow Jones)--The 4.3% plunge in Nymex crude oil futures Thursday may set the stage for a sharp recovery down the road by spurring OPEC to cut output again in the face of its two main concerns: high inventories and weakening prices.
But in the near-term, the selloff to the lowest price in a year - coming a day before contract expiration and a holiday shortened trading period – sends further conflicting signals into an already mixed-up market as it hovers near a key level of $56.00 a barrel.
In figuring out the issue of whether oil inventories are too high, the right conclusion seems to be both a definitive "yes" and an absolute "no."
In the "too-high" camp is the Organization of Petroleum Exporting Countries, which plays a pivotal role in setting near-term prices. Oil inventories held by the major industrialized countries ended the third quarter at their highest levels since 1998, after the biggest gain in the period since 1991, which has OPEC talking of further cuts.
In the "too-low" camp, are traders pointing to the fact that in the world's biggest oil market, stockpiles of key petroleum products have tumbled in recent weeks as demand has risen.
The existence of the two camps has kept oil prices camped out in a tight range with a mid-point of near $59 until the latest plunge. And prices now don't look likely to be able to muddle in the middle much longer.
OPEC is talking about a further cut in crude output when it meets on Dec. 14 in Nigeria, even as the extent of the agreed cut of 1.2 million barrels a day from Nov. 1 isn't clear.
US Crude Stocks Tighter
If OPEC's tighter rein on output trims stocks, prices could be poised to move sharply higher. A close look at U.S. crude oil inventory levels suggests they are far tighter than they would appear, with an unusually high concentration of stocks on the West Coast, which is viewed almost as an island, separate from the true national supply/demand grid.
But much will depend on the severity of winter weather. The upcoming U.S. winter will be warmer than the 30-year average over much of the country, but cooler than last year's very warm winter season, the National Oceanic and Atmospheric Administration reiterated Thursday.
NOAA's heating-degree day forecast for December, January and February projects a 2% warmer winter than the 30-year average, but about 9% cooler than a year ago. Heating degree days is a calculation of the average of each day's high and low temperatures for a region relative to 65 degrees.
The federal Energy Information Administration has said that as a rule of thumb, a 1% increase in heating degree-days increases heating fuel consumption by about 1%.
NOAA repeated its expectations for a strengthening El Nino event continuing into Spring 2007, signaling warmer weather in the Northeast U.S., the world's biggest heating oil market. El Nino is an unusual warming of ocean waters in the equatorial Pacific.
El Nino isn't expected to strengthen to the level of the one in 1997-98, which combined with the start of the Asian economic crisis and an ill-timed 10% rise in OPEC oil output quotas, sent oil price crashing by half to below $11 a barrel. Prices didn't recover to pre-crash levels for two years.
Still, traders were burned by bets on the weather this summer, when a feared repeat of the devastating 2005 hurricane season didn't materialize, slashing Nymex crude oil futures prices by some 25% from mid-July record highs of $78.40 a barrel.
Crude prices tumbled on Thursday, with December futures, which expires at Friday's settlement, settling down $2.50 a barrel at $56.26., the lowest since last Nov. 18. The true market trend may not be clear for several days as expiration-related trading leads into the Thanksgiving holiday week, when Nymex is closed Nov 23 and 24.
All Eyes On Distillates
Traders were surprised to see a sharply higher than expected drop in U.S. inventories of distillate fuel (diesel and heating oil) in the week ended Nov. 10. The EIA showed stocks fell by 3.6 million barrels in the week, as demand jumped to its highest ever November level and the most since mid-February 2004.
EIA analysts cautioned that it's difficult to draw conclusions from the current data, saying exports may play a hidden role in steep declines and strong apparent demand. The agency doesn't track exports on a weekly basis, but noted anecdotal reports of increased shipments of diesel fuel to central and south American countries.
Analysis of EIA's numbers shows an implied level of distillate exports in the past two weeks of 250,000 barrels a day, well ahead of the typical November monthly average of 100,000 barrels a day in the past five years. Distillate exports haven't been higher than 250,000 barrels a day on a monthly basis since February 2002 and haven't been near that level in November since 1993.
Distillate inventories still remain in the upper half of the five-year average range, despite four-week average demand of near 4.5 million barrels a day, the most for any four weeks outside of the peak January-February demand period. But relative to expected demand, stocks are near their five-year averages.
The EIA also warned that strong apparent demand this early in the year doesn't mean winter demand will be even higher. The data reflects movement of products from primary storage, such as refinery tanks, not actual end-user consumption. That means tanks at heating oil distributors and in consumers' homes may be higher than normal, potentially lessening needed stockdraws in coming weeks and months.
While the market is focused on the coming winter, U.S. gasoline stocks in the latest week fell below year-ago levels for the first time since July 7 and are "now in the lower half of the average range" for the past five years. Gasoline stocks have fallen by more than 15 million barrels since the end of September against a backdrop of extraordinarily high demand and reduced refinery operations.
Rebound In Refinery Runs
Crude input to refineries has been lower than expected, but is expected to turn around soon, pumping up products stockpiles and trimming crude inventories. Crude runs have averaged just 15 million barrels a day so far in November, about 400,000 barrels a day below EIA's expected rate for the full month.
"The twin forces of OPEC production cuts and rising refiner demand will evidently determine in the week/months ahead by how much U.S. crude oil inventories will fall," said Jan Stuart, an economist specializing in oil markets at UBS Securities in New York.
Much of the weakness in runs and the overhang in crude stocks is occurring in
the isolated West Coast market, meaning the true picture of the market is tighter than it seems.
Crude oil stocks in the Western U.S. now cover more than 25 days of regional refinery needs, the highest level since March 2002, as crude processing at refineries has slowed, while imports have risen. Western crude stocks rose 600,000 barrels in the latest week - accounting for almost half of the 1.3 million barrel rise nationwide. At 58.918 million barrel, regional stocks are the highest level since July 26, 2002.
Nationwide crude stocks are 4.3% above a year ago, but when Western region stocks are dropped out, inventories are only about 3% above year ago levels, near where they were in late 2004 when OPEC's last cut sparked a sustained rally in prices.
Source: David Bird, Dow Jones Newswires; 201-938-4423; david.bird@dowjones.com